Foreign Investment in China

China employer audits China employment lawyers

As I have previously written, no (foreign) employer is too small for China’s regulators and in some respects the smaller you are, the more you need one. I say this because when a company with 5,000 employees has a problem with five employees, it’s not that big a deal, but when a five-employee company has a problem with two employees, it can be such a big and costly problem as to cost the company its China business. To be a well-protected employer in China, you need a well-written China employment contract and a China-centric set of Rules and Regulations, no matter your company size.

China’s employment laws are strict and protective of employees at all companies, especially those that are foreign-owned. If you as an employer fail to follow all mandatory employment laws, your employee will pursue you regardless of your size. Our China employment lawyers constantly get questions from China employers after they have been reported and/or sued by an employee China employee — mostly Chinese but increasingly non-Chinese as well.

The below is an amalgamation of the sorts of emails we frequently receive:

I cannot believe that I just got served with a lawsuit by one of my former Chinese employees. We are a small business and we pay all our taxes and we have always treated all of our employees right, including this one. We paid her really well and we were never late with her wages and we even gave her extra vacation days. We also paid all of her mandatory employee benefits and a few optional ones as well. We always did our best with her. And then she quit, completely voluntarily, and yet she is now suing and claiming we owe her double her monthly wages for not having a written employment contract with her? As you can see, her demand is totally unreasonable.

We then have to explain that with no written employment contract the employer stands virtually no chance in this arbitration.

It is not uncommon for foreign employers in China to state that they have done or are “doing their best” with respect to treating their employees well and following China’s complicated (and localized) employment laws. The problem is that neither the Chinese government nor its courts nor arbitral bodies care how hard you try. Your other law-abiding actions are not a mitigating factor in determining the penalty you will need to pay for having failed to enter into a written contract with your employees or for whatever other violation you may have committed.

The burden is on you as the employer to ensure you have a proper written employment contract fully executed by the parties. The best practice is to have your new employee sit down and sign a hard copy of the employment contract on her first day and you then retain an original copy of the fully executed contract for your records.

Consider this hypothetical. Employer asks Employee to sign a hard copy of the employment contract during the on-boarding process. Employee says: I will need some time to review this and I will take it home to read and I will return a signed copy. Employer says okay, but the Employee never returns a signed copy. Employer never makes an effort to “track down” that contract. Employee sues months or years later seeking a penalty from the employer for failing to use a written employment contract. Under this scenario, the Employer will be liable to Employee for failing to execute a written employment contract. If this sort of scenario sounds unlikely to you, let me just tell you that nearly every time we audit a company’s employment situation we find some percentage of employees working without signed contracts.

Now same facts as above, but Employee returns a signed copy with a fake signature. What will happen? Based on real cases with similar facts, Employer will probably be held liable for an employer penalty because there is no written employment contract bearing Employee’s actual signature, unless Employer has convincing evidence Employee faked the signature to “cheat the system” (which is a high evidentiary bar to meet).

If you are not sure you have current written employment contracts for all your employees, now would be a good time to check on this and fix it.

China Employment Law Female EmployeesAs today is International Women’s Day, this would be a good time for a quick overview on China employment laws that directly relate to female employees. Since there are so many national and regional and even local laws and regulations regarding female employees in China, this post necessarily seeks only to hit the high notes.

First, do not forget to give your female employees half a day off as International Women’s Day is their holiday (or follow the applicable holiday policy in your employer rules and regulations if it’s more generous than the law)!

Second, let me emphasize that female workers are always a big issue in China (not just today), primarily because they are accorded many additional special protections under China law. If you have been following my posts here or if you have a copy of my book (The China Employment Law Guide), you probably already know that employees who are pregnant, nursing or on maternity leave receive special protections exceeding those in many other countries. However, it is important to also note that these are not the only protected subgroups of female employees; they are simply the most often mentioned because the issues relating to them are the most common and because it is on these issues that foreign employers so often find themselves in trouble. For example, China’s laws also provide special protections for female employees during their menstrual periods. Many localities in China require employers provide a short (usually 1 to 2 days) paid leave to employees suffering from serious menstrual issues or to those with very heavy flows during their periods, so long as the employee provides a doctor’s note proving her condition.

Terminating a China employee is generally very difficult because China is not an employment-at-will jurisdiction and terminating a female employee is often even more difficult, especially if the female employee has a special status such as pregnancy. Subject to limited exceptions, employers in China are prohibited from unilaterally terminating an employee who is pregnant, nursing or on maternity leave. One common myth is that female employees in such special status can never be fired. This is wrong as these employees may be unilaterally terminated without severance for the employee’s failure to satisfy the employer’s conditions of employment during a probation period or if based on employee misconduct or wrongdoing. Alternatively, such an employee may be terminated if the employer and the employee agree to mutually terminate the employment relationship. See Terminating a China Employee: Why Mutual Termination is so Often the Key.

I will next month be putting on a webcast on April 18 on Employment Law for Female Workers in China. Do not miss it!

China WFOE Formation
China WFOE Formation. It’s complicated.

Yesterday, in the first part of this two-part series, I discussed how China is requiring foreign companies reveal all layers of WFOE ownership in the WFOE formation stage, I talked about how just as so many foreign companies are realizing the importance/necessity of forming a China WFOE, China has made it nearly impossible to form a WFOE without a full list of its owners. I first wrote about this issue in China’s New Foreign Investment Law: The “Actually Controlling Person” Requirement is Going to be Tough, but it is now at the point where the China lawyers at my firm are very clear with our clients who seek to retain us to help them form a China WFOE: you either reveal pretty much all owners of the WFOE-to-be (through the various layers of ownership) or your chances of getting a WFOE are not good. Clients unwilling or unable to make the required ownership disclosure in the exact form required by the PRC government authorities cannot proceed. There are no exceptions to the rule.

As noted in my earlier post, this is a threshold issue and this issue must be resolved before it makes sense to incur the time and expense required for aWFOE formation application.

China’s intent with this new [ownership disclosure] system is clear. The PRC government will no longer allow the use of special purpose vehicles and related entity structures to hide the actual ownership of the investors in PRC foreign-invested enterprises. And any attempt by a foreign investor to invoke a foreign law that allows secrecy with respect to ownership will [almost surely] be ignored. MOFCOM has plans to carefully audit all FIEs and that audit will include carefully reviewing their ownership structures. More important, however, is that a response that does not list out owners will simply not be accepted by the automated system. A response is therefore forced. A false response is a violation of law that can result in penalties and other legal/administrative action by the PRC government and its agencies.

Consider a typical private equity fund/venture capital type of ownership structure. The investor in the WFOE is Operating Company A. The owner of Operating Company A is a Holding Company B. Holding Company B is in turn owned by three private equity funds: Equity Funds C, D and E. The largest of the funds is owned by Equity Fund Z. As you can see, there are four layers of ownership.
For the MOFCOM information report, it is certain we will be required to disclose the following:
  • Operating Company A as the investor. This will require disclosing the officers and directors of Operating Company A.
  • Holding Company B is a 100% shareholder of Operating Company A. This will require we disclose Holding Company B, together with its officers and directors. We usually argue that Holding Company B is a “private equity fund”, and for that reason, we should not be required to disclose the shareholders of Holding Company B. Some MOFCOM offices will accept this argument. Some will not. Even if the local MOFCOM accepts, the higher level MOFCOM that does the later audit may not accept and then require all shareholders of Holding Company B be disclosed.
  • The local MOFCOM office may require disclosing the three shareholders of Holding Company B. If MOFCOM makes this demand, it will also require disclosing the directors and officers of Holding Company B. For the past several months, most MOFCOM offices have required this level of disclosure and foreign investors should plan on this disclosure being required.

The big question is whether MOFCOM will require moving up the chain to mandate disclosing the shareholders of the three shareholders in Holding Company B (Equity Funds C, D and E).  We have in the last few months been asked by various MOFCOMs for this level of disclosure, but we have so far been able to convince them that this should not be necessary. In one instance, we provided MOFCOM with an organization chart showing nearly 75 owners of an LLC (including many private equity funds) but ended up convincing it not to require our client disclose the names of these nearly 75 owners, as originally requested. When MOFCOM requests/requires this sort of disclosure, we normally argue that the C, D and E entities are “private equity funds” and disclosure of their ownership should not be required for the same reasons public company investors are not required to disclose their shareholders. Several local MOFCOM offices have recently tentatively accepted this argument, but this decision is not binding and the higher level of MOFCOM could demand more disclosure, either as part of the initial WFOE formation process or later as a result of their audit.

China has rejected shareholder secrecy and its requirement of full shareholder disclosure imposed on foreign investors is simply the consistent application of PRC law to all legal persons. The shareholder disclosure requirement is contrary to European and North American legal principles and on that basis many shareholders will refuse to consent to disclosure. However, under PRC law, there is no exemption. Moreover, as noted in Part One of this series, PRC local governments and MOFCOM offices are authorized to require even more sensitive private documents, such as the shareholders’ tax returns and tax returns of the WFOE’s foreign employees.
Bottom Line: If you are unwilling or even legally unable to comply with China’s ownership disclosure requirements you cannot proceed with a China WFOE formation. It is that simple and resistance is futile.
China Manufacturing Contracts
China WFOE Formation Ownership Disclosure: Like a Maze

Just as so many foreign companies are realizing the importance/necessity of forming a China WFOE, China has made it nearly impossible for a WFOE to be formed without a full list of its owners. I first wrote about this issue in China’s New Foreign Investment Law: The “Actually Controlling Person” Requirement is Going to be Tough, where I predicted what has now transpired.

It has reached the point now where we are very clear with our clients who hire us to help them form a China WFOE: either you reveal pretty much all owners of the WFOE-to-be (through the various layers of ownership) or the odds of your getting a WFOE are not good. Clients unwilling or unable to make the required ownership disclosure in the exact form required by the PRC government authorities cannot proceed. An Anti-Money Laundering Letter will be ignored and insisting on such a letter will only produce a hostile response. There are no exceptions to the rule.

This is a threshold issue and this issue must be resolved before it makes sense to incur the time and expense required for aWFOE formation application.

I provided the explanation for this in my earlier post:

China’s intent with this new [ownership disclosure] system is clear. The PRC government will no longer allow the use of special purpose vehicles and related entity structures to hide the actual ownership of the investors in PRC foreign-invested enterprises. And any attempt by a foreign investor to invoke a foreign law that allows secrecy with respect to ownership will [almost surely] be ignored. MOFCOM has plans to carefully audit all FIEs and that audit will include carefully reviewing their ownership structures. More important, however, is that a response that does not list out owners will simply not be accepted by the automated system. A response is therefore forced. A false response is a violation of law that can result in penalties and other legal/administrative action by the PRC government and its agencies.

Since I wrote that post, the China lawyers at my firm have found the local MOFCOM authorities are becoming even stricter about enforcing its WFOE ownership disclosure rules. The current trend is to require full disclosure all the way up the line of ownership. The only concession we have recently received is that some local governments will agree to end the disclosure at the level of what can be called a private equity or SICAR type fund. That is, some (not all) local MOFCOM offices will not require disclosing investors in private equity fund/SICAR type entities. However, other local MOFCOM offices DO require disclosure of private equity fund/SICAR investors.

There are though two levels of disclosure and getting past MOFCOM just means getting past the first level. The first disclosure is made in the information report provided to MOFCOM as part of the formation process. However, the new system includes an elaborate auditing process, so even if a local MOFCOM office allows for limited shareholder/ownership disclosure, an expanded disclosure may be required as a result of an audit. This is because the audit is done by a higher level office of MOFCOM. Such higher level offices are almost always stricter than the low-level offices.
So even if you are able to convince a local MOFCOM office to accept a limited disclosure of the shareholders of the investor, this is not a final decision. The initial MOFCOM decision can be overturned at any time and the demand for full disclosure can be made at any time. This demand would likely be made after your WFOE has started operations and if you then fail to comply with the demand your WFOE would be at great risk of being shut down.
Our European clients are usually the most taken aback by China’s new ownership disclosure requirements and we therefore often must spend extra time explaining the situation to those clients. Investor secrecy is at the heart of the European investment system. Most SICAR entities do not even disclose the identity of directors and officers. However, this form of secrecy has been rejected by the PRC government. For domestic companies that are not publicly listed entities, all shareholders are listed on publicly available websites. It is now possible to trace every PRC corporation up to the point of either a natural person shareholder or a public company shareholder. This is the system the PRC government intends to impose on foreign investors in China.
The investor disclosure requirement has become a fundamental policy in Chinese law. The PRC government fully understands that its policy of full investor disclosure is exactly opposite the investor secrecy systems standard in Europe and North America. Accordingly, any argument from a foreign investor that invokes European or international law is simply ignored as irrelevant. As noted above, as foreign entities have tried to resist fully disclosing their ownership, the PRC authorities have become more demanding, not less. We expect this trend to continue.
Note also that there are other disclosure risks, including the following:
  1. As part of the audit procedure, the PRC government may demand the tax returns of the disclosed shareholder(s) to confirm the accuracy of the reported information.
  2. It is nearly certain the PRC government will at some point require the WFOE provide three years of personal tax returns for each foreign individual employed by the WFOE.
  3. Other intrusive requests for what you likely will consider very private personal information may also be required during the life of the WFOE.
If you are not willing to provide the required information you should not move forward in trying to form a China WFOE because there is no way around these requirements. The PRC laws in this area are clear and the fact that those laws conflict with the laws and norms of Europe and North America is simply not relevant. What is relevant is that if you are not willing to comply with China’s ownership disclosure laws, you will not be permitted to set up and operate a WFOE in China.
As I wrote in my previous post, the “actual controlling person” requirement does not make legal sense under modern corporation structures, but the PRC government simply ignores this fundamental point. Thus, even after we do a full disclosure of all shareholders and thereby PROVE there is no single actually controlling person, the response of MOFCOM is to say: “You must identify the actual controlling person or we will not approve the investment.” Most local MOFCOM offices accept the name of the Chairman/CEO of the first level shareholder as the “actual controlling person.” Even that result though is not certain and there are two other possibilities:
  • The CEO/Chairman/Managing Director of the majority owning private equity fund or SICAR, no matter how far up the chain of ownership.
  • Endless requests for the name of the actual controlling person, when in fact there is no such person, making a response to the request impossible.
Our China attorneys have encountered all three of the above in our work on WFOEs during the period after the actual controlling person requirement was imposed. To date, there has been no consistency in the requirements.
In part 2 of this post, to come out tomorrow, I will discuss some of the specific situations we have encountered regarding ownership disclosure requirements when trying to register a China WFOE.
China employees during WFOE formation
Be safe. Hire after your China WFOE has been formed.

If you are a foreign (i.e., non-Chinese) entity with no legal presence in China, you cannot directly hire any employees in China. The basic rule is that you cannot hire a Chinese individual until after you have formed an entity (e.g., a WFOE) there and violating this rule can (and nearly always does) bring all sorts of bad things down on everyone involved. See Doing Business in China with Deportation or Worse Hanging Over Your Head.

What though do you do if you are in the process of forming your WFOE in China? Can you bring on employees during that time to assist with setup and other such things? Surely during this usually three to five month period, it is okay to bring on people and pay them as “employees” and then “convert” them over to legal status employees as soon as the WFOE is formed. Unfortunately, this is technically not allowed; there is no way for a foreign entity to hire a Chinese national “directly” unless and until it has an entity (a WFOE or a Joint Venture) in China. Sending illegal payments to your Chinese “employees” is not “hiring directly;” that is engaging in illegal activity before the WFOE is formed, and it is generally not a good way to start.

Though there is absolutely nothing in Chinese law that allows for “hiring” an “employee” before a WFOE is formed, the truth is that none of our Chinese lawyers have heard of anyone getting in trouble for this. This is not to say though that bringing on workers during the formation phase of your WFOE is not without risks. First off, past performance is no guarantee of future performance. Second, everything in China is somewhat local and that is particularly true of anything related to employment. See China Employment Law: Local and Not So Simple. In other words, what works in Shenzhen may not work in Shanghai, and vice-versa. And you must realize that for tax collection reasons the Chinese government is on a constant lookout for foreigners doing business in China without a WFOE and they have become exceedingly good at finding them.

The biggest risk of bringing on workers during the formation phase of your WFOE probably comes from the workers themselves. If things go well with them, no problem. But things very often do not go well with Chinese “employees.” Here is an all too common situation: a foreign company hires a Chinese person to work on the ground before the WFOE comes into existence. This Chinese person does something illegal in China and the foreign company informs the Chinese person that he is fired.  The Chinese person then says: “you cannot fire me because my engagement was illegal and that means you are operating illegally in China and everything I did that you say was illegal was done for the company and so you (the company) were doing illegal things too. I know more about these things because I am the one who was doing them but if I report them I won’t get in trouble for them, you will.”

If the foreign company terminates the employee that individual will no doubt files a lawsuit for unlawful termination AND report the foreign company to the Chinese government and then the WFOE and its management get in trouble, in addition to having to take the employee back because the termination was unlawful. The best resolution at this point is virtually always to reach a settlement with the “employee,” but because the “employee” has so much leverage in this sort of situation, the company usually has to pay quite a lot of money to extricate itself from the rogue “employee.”

Even after the WFOE is formed the new WFOE is at some risk of one of its pre-WFOE “employees” ratting it out for the pre-WFOE hiring, but that is much rarer. To ameliorate this risk, we always advise that you give your employees seniority and full other credit for any time spent working for your company during its pre-WFOE days.

Bottom line: Not bringing on Chinese employees directly while in the process of forming your China WFOE can be inconvenient, but it is always the safest route.






China Stock Options and SIPs
China stock options and share incentive plans

Companies often use share incentive programs to motivate employees by tying compensation to their service. Though no foreign person can own stock in a private Chinese company, it is possible for a PRC employee of a foreign company’s Chinese subsidiary to participate in the foreign company’s employee share incentive plan (“SIP”). However, due to China’s currency controls, whether such an employee can actually “cash out” on the benefits of such a program depends on whether the foreign company is or becomes listed on a foreign stock exchange at the time of exercise.

The primary rules on PRC citizen employees participating in a foreign company’s SIP come from the Circular on Foreign Exchange Administration of Domestic Individuals Participating in Share Incentive Plans of Foreign Listed Companies [2012] No.7 (“Circular 7”,  issued by the State Administration of Foreign Exchange (“SAFE”).

  • Registration and Designated Account

Under Circular 7, a foreign listed company can offer SIPs to its PRC subsidiary’s employees in China via an incentive plan. The incentive plan must be registered with the local SAFE office where the foreign company’s domestic agent is located. This domestic agent can be the PRC subsidiary of the foreign listed company participating in the SIP (if multiple places, then the location of the headquarter) or a third party domestic entity that is qualified to provide asset custodian services.

Once the registration is complete, the domestic agent must open and maintain a domestic foreign exchange account designated for handling foreign payments and collecting money for all domestic individuals participating in the SIP of the overseas listed company. Any payments under the incentive plan must go through this special account before they go to an individual participant’s bank account.

Again, just like China employment contracts, we cannot emphasize enough how SAFE registration is highly local. It is critical to consult with the local SAFE office about specific requirements for registration before submitting an application. And just as is true of pretty much anything and everything in China, you do not want to get halfway through the process before you realize you are doing it wrong because this will make doing it right more difficult or perhaps even impossible.

  • Type of Awards Covered

Under Circular 7, share incentive plans mean any incentive plan where the shares of the foreign listed company are offered to directors, supervisors (officers who supervise directors and senior management of a company, a position created under the PRC Company Law), senior management employees, other employees of the domestic company or individuals who have a labor relationship with the domestic company. This includes employee stock option plans, share ownership plans, and any incentive plans permitted by law.

Though Circular 7 does not enumerate the specific types of awards to which it applies, the relevant registration form provides checkboxes for the following types of awards: stock ownership plans, stock options, stock appreciation rights, phantom stock, restricted stock (units), performance shares (units), and stock purchase plans.

  • Nationality of Participants

Circular 7 defines “domestic individuals” as directors, supervisors, senior management and other employees within the scope of article 52 of the Regulation on Foreign Exchange Administration who are PRC, Hong Kong, Taiwan, and Macao nationals, and other foreign nationals who have resided within China for one year on a continuous basis, except foreign diplomats in China and the representatives of any international organizations in China.

  • PRC Employees and Foreign Private Company Incentive Plans

Certain special rules apply to special purpose vehicles (foreign companies established or controlled by PRC residents or organizations) and PRC law and Circular 7 are silent on domestic individuals participating in purely foreign private companies’ SIPs. This does not mean Chinese individuals are not allowed to participate in a foreign private company’s SIP, but the lack of clear legal authorization makes it practically impossible for PRC individuals to receive benefits or awards under those plans if the foreign company is not yet public by the time of exercise.

And again, because SAFE registration is so highly localized, even though the law does not require registration of a private foreign company’s SIP, it is advisable to consult with the local SAFE office and attempt registration anyway. It doesn’t hurt to ask.

A foreign company with a concrete plan to become publicly listed in the near future can enter into an agreement with its employees in China to offer stock option or other awards. If the company does go public as planned, such awards can then be registered with SAFE and special accounts can be created to process payments in compliance with PRC laws. However, when entering into such agreements, the company should also make sure its employees in China understand that if the company does not go public, the employees may never receive SIP related proceeds due to China’s foreign exchange control rules.



China WFOE Formation
How to name a China WFOE

Strange but true: WFOE formations are seasonal and fall is for our law firm always the busiest time of the month for WFOE formations. Like clockwork every year, companies come to us in September and October seeking our help in getting their WFOE formed “by the end of the year.”

This plethora of WFOE formations has meant a correspondingly large number of e-mails from our China lawyers to our clients explaining the steps required to form a WFOE in China. Because these emails are helpful to anyone forming a WFOE in China or even just considering doing so, I will from time to time run some of those on here. Today’s email is about choosing a name for your WFOE.

It is necessary to select a Chinese language name for your WFOE. In choosing the name, please note the following:

1. In China, only the Chinese language name has any legal status; as a legal matter, the English is not relevant. This means you can use any English language name you want.
2. Chinese company names follow this rigid structure: [City of formation] Company Name [business type] [Company Ltd.]
So, an English equivalent of a typical Chinese company name would be: Shenzhen ABC Consulting Co. Ltd.
The elements in [] square brackets are fixed by the local government. This means the only thing we need determine now is the Company Name. Since as you can see, company names can get rather long, it is usually best to limit the Company Name part to 3 or 4 Chinese characters at most.
3. The company name must be different than any other company registered in your same kind of business. It is often surprising how many good names are already taken. For this reason, the local authorities require we submit AT LEAST five alternative names and they (and we) prefer ten alternatives if possible.
4. There are two approaches to selecting a Chinese company name. You can pick a descriptive name or you can pick a name that has no meaning but is intended to reproduce only the sound of the parent company name. When descriptive names are used, investors often make the mistake of choosing names that are too long. As noted above, the name should be limited to three or at most four Chinese characters.
5. You will need a native speaker of Chinese to assist you in choosing the names. Some companies simply work this out with their current staff. Some companies hire a public relations or a branding company to work with them on the issue. Note that your Chinese company name will become your identity, so a careful choice is advised. We can give you names of some branding companies with whom we have worked on China matters.
6. When you have chosen your names please submit them to us for a preliminary review. We check to see if there are any obvious conflicts with existing names and we also can give you some advice on the suitability of the names selected. We will then work with the local government to devise the full Chinese name to be used on the WFOE registration papers.
We realize this WFOE naming process can be somewhat confusing and so we urge you not to hesitate to reach out to any of us for further assistance on this or on anything else on which we are working to form your China WFOE.
China WFOE ownership lawyer
Who should own your China WFOE?

Late last year, China revamped its WFOE formation rules and — as much as anything, these new rules have complicated ownership structures. The below is an email from one of our China corporate lawyers to a client


As we discussed today, the first task in forming a WFOE in China is to determine what entity will be the shareholder of the WFOE. The basic analysis for this is as follows:

1) You will be creating an entity that will perform services for a fee for its shareholder parent. For this type of WFOE, the normal procedure in China is for the shareholder to be the specific entity for which the WFOE will perform services. In this case, this entity would be ABC US. The Chinese WFOE would then be another of your company’s several direct subsidiaries. Direct ownership of the WFOE by the operating company parent is most common in single owner WFOEs, such as that planned for ABC US here.

2. The alternative you are considering is whether or not the shareholder should be a separate holding company not directly linked to ABC US. This is what is referred to in China as a Special Purpose Vehicle (SPV). It would be unusual but permissible to make use of an SPV in your situation. The analysis here is as follows:

a. Over the past decade, the Chinese government has become quite suspicious of SPVs. At one point, the government even moved to prohibit SPVs for WFOE formations. However, after recently adopting the new WFOE formation rules, the Chinese government now permits the use of SPVs. So the current Chinese government rules are neutral on the issue.

b. In the past, one reason investors used an SPV was to hide the true identity of the owners of the WFOE. Under the new rules, the investor must provide a complete organizational chart detailing ownership of the shareholder and identifying the actual controlling person. It is therefore impossible to conceal ownership. Accordingly, an SPV can no longer be used to conceal actual ownership from the Chinese government.

c. SPVs continue to be used in situations where there are several investors in the WFOE. Often these investors are resident in different jurisdictions. In that case, it is common to take all these investors into a single SPV. The SPV is then the single shareholder of the WFOE. Issues such as management, distribution of profits and purchase and sale of ownership interests are handled at the SPV level. In many cases, the SPV is formed in a tax haven such as Hong Kong to allow distribution of profits free of tax. These considerations do not apply in a single shareholder setting.

d. In terms of limiting upstream liability to the shareholder, there is no benefit in making use of an SPV. The WFOE will be a limited liability legal person. The limitation of liability rules apply in China in the same way as in the United States in that the financial liability of the WFOE is limited to the amount of investment. Liability beyond the investment amount occurs only in the case of illegal acts. In general this liability would be as follows:

i. The shareholder will be held liable if the shareholder does not contribute capital and the failure to contribute capital results in non-payment of taxes, non-payment of employee salaries or fraud against creditors.

ii. Directors will be held liable for instructing the WFOE to commit an illegal act. Examples of illegal acts are tax fraud or commission of a significant safety violation.

iii. Directors and the shareholder will be held liable if the WFOE terminates business and does not liquidate in accordance with the provisions of Chinese company law. The penalty here is that both the investor and the directors are placed on a blacklist and prohibited from doing other investments in China. In addition, individual directors will not be able to travel to China since they may be detained.

All of the above liability is very real. However, creating an SPV does nothing to reduce this liability. First, most of the liability falls on the individual directors, not on the shareholder. Second, the Chinese government will use the org chart/actual controlling person information to “pierce the corporate veil” to assign liability to what the Chinese government determines in its own discretion is the actual party/parties in interest.

Note that other reasons for liability arising from WFOE operations are so rare that they can usually be discounted. On the other hand, i, ii and iii above are common and care must be taken not to incur these forms of liability.

3. There may be tax or other operational or accounting reasons to create an SPV for China. In that case, as noted above, the Chinese government is neutral about the use of such SPVs. In considering whether to make use of an SPV, you should do a cost-benefit analysis. Most of our firms’ clients have found the SPV approach to be more trouble than it is worth in the single shareholder setting. However, your situation may be different and we should explore the tax ramifications before you make this decision.


We are always emphasizing on here how you need a China-centric contract when doing business in China or, in most cases, even with China. See China Contracts: Make Them Enforceable Or Don’t Bother. This holds doubly true for employment contracts with China employees because everything about such agreements is highly local. If you are having someone in China other than a company performing services for you, you need both your own entity in China (See Doing Business in China with Deportation or Worse Hanging Over Your Head) and a China specific written employment contract with each of those individuals.

China employment law
Don’t let your China employment agreement get lost in translation

And though I should not have to say this, translating your existing employment agreements into Chinese is not going to cut it — not even close. Yet just about every month some foreign company (almost invariably an American or Australian company for some reason) or an executive with such a company (again, almost invariably American or Australian) will come to one of our China employment lawyers with a problem involving a foreign country employment agreement that was translated into Chinese.

The below are some of the common examples we see where a foreign contract/foreign mindset does not jibe with the China employment law reality.

  1. The employment agreement makes clear the employee is being hired on an at-will basis, which means he or she may be fired for “good reason, bad reason, or no reason at all.” This generally works in the United States and in a few other countries around the world, but it absolutely positively does not work in China and putting such a provision in your employment contracts can and often is used as evidence to support a wrongful termination claim, so please just skip it. Terminating a China-based employee nearly always requires good cause and far too often companies that put these at-will provisions in their China employment contracts actually believe what they say and end up in big trouble for wrongful firings.
  2. The employee is expected to work whenever needed to get the job done. This can sometimes work for certain China employees provided various specific conditions have been clearly met, but putting this sort of provision in a contract is not a way to meet those conditions — it is yet another red flag for China judges when you get sued by one of your employees. For you to be able to use your China employees after hours without having to deal with overtime provisions, that employee must (1) have been cleared by the appropriate labor bureau authorities as eligible to work under an alternative working hours system, (2) have specifically agreed in his or her employment contract to work under such an arrangement. Note also that clearance for one of your employees being able to work under an alternative working hours system typically lasts for only a year, depending on the locality. Note also that the alternative working hours system cannot be used with most employees and that means they must work under the standard working hours system which requires overtime for anything beyond 8 hours a day and 40 hours a week. Getting an employee to consent to this without government approval does not work.
  3. The employee agrees to adjudicate all employment-related disputes through arbitration. This does not work if you try even to limit your employees to only labor arbitration and it certainly does not work if you try to require your employees to arbitrate disputes against you in your home country or really anywhere outside the jurisdiction where they are employed. I surprisingly often have to tell American companies that putting a provision in a contract with a China employee that United States law will apply and all disputes must be resolved in some U.S. city has the same likelihood of success in China as would a provision requiring an Omaha employee be bound by Chinese law and Chinese jurisdiction, which is exactly zero. Think about it. Is any American jurisdiction going to let you hire someone and pay them pursuant to China’s minimum wage requirements? Of course not, and the reverse is equally true.
  4. The employee agrees to a non-compete that comes into force after termination of employment and the consideration for this non-compete is the promise of employment. This generally works in the United States (though not in California), but in China, if you want one of your employees to be bound by a non-compete provision, you must pay them consideration for their not competing during the entire term of the post-termination non-compete period. For example, a sign-on bonus may not be consideration for a China non-compete; the (former) employee must receive compensation via bank transfer on a monthly basis after termination for your non-compete to hold.

Provisions like the above send strong signals to your employees, to China labor bureau authorities and to China’s courts that you do not understand how China’s employment laws and you are not willing to make the effort to comply with them. This increases both the odds of your having China employment law problems and the odds of your employees suing you when such problems arise. And as mentioned above, having these unenforceable and illegal provisions in your China employment contracts also tends to prejudice judges against you when you are actually sued.

Bottom Line. Use a China-centric employment agreement with all of your China employees.


China WFOE
Photos from Hong Kong Free Press

According to the Hong Kong Free Press (and a number of other newspapers) The Shanghai government this week “ordered the closure of one of the city’s top maternity hospitals saying that it was illegally built on land owned by the armed forces, according to an official notice.”

According to the article, the hospital, Shanghai Redleaf International Women’s and Children’s Hospital, was “founded by Canadian investors” and it had “signed a 20-year lease for prime real estate owned by the military on central Shanghai’s Huaihai Road and started catering to foreigners and wealthy Chinese more than four years ago.” But because “The People’s Liberation Army has been banned from commercial activities since 1998” the hospital was being forced to close. The HK Free Press says this “hospital is one of the largest private business affected by the so-called de-commercialisation of the military to date.” The article then quotes the district government as saying “There exists a matter of illegal construction of building at the Redleaf Hospital. It must be rectified duly in accordance with relevant laws.”

Not surprisingly many patients and hospital employees were not happy with the closure:

A gynecologist who was vacating her workplace Sunday afternoon said that the owners, a Canadian couple, had invested billions [of RMB, presumably] into the clinic. “They had all the right documents and invested so much money… it just doesn’t seem fair,” she said.

Christine Cheng had been working as a nurse at Redleaf’s gynecology department for almost two years. “We spent a lot of money and work building this, and now the government wants us to move… We didn’t do anything bad,” she said.

When news transpired last Thursday that the upscale facility would be forced to close, some of the about 300 staff affected hung banners outside the main building criticizing the facility’s imminent closure.

The banners said that while the hospital supported the government, it shouldn’t be forced to move, adding that it wasn’t a “soft tomato” — a Chinese expression for a pushover. Police arrived on the scene shortly afterward and ordered that the banners be removed.

Louise Roy, director of patient support services at Ferguson Women’s Health, a clinic that rents facilities inside the Redleaf complex, said that staff first heard about the possibility of a closure several months ago, although they were never given confirmation or a specific date. “They’ve told us nothing — absolutely nothing,” Roy said. “We came in this morning, like [we do] every day. Then we saw staff gathered outside where the banners were hung, and then the police came.”

Several women who were being treated at the hospital were clearly upset as they collected their medical records before closure.

“I found out from a friend,” said a 32-year-old patient named Jennifer who would not give her last name because of privacy concerns. She said that she had moved to Shanghai from the U.S. recently and was planning to deliver her child at Redleaf in three months. “I have friends who are due in two weeks or a month — I don’t know what they are going to do,” she said.

Wang Jue, PR supervisor, said that one patient in labor arrived at Redleaf over the weekend and was turned away by government officials. She arrived at another clinic just 10 minutes before giving birth.

Redleaf’s services have been highly sought-after by those who can afford them. A standard cesarean section delivery at the hospital costs 120,000 yuan, and a prenatal package is priced at 24,000 yuan.

Patients have been referred to a temporary clinic while Redleaf is working on a more permanent solution.

I do not know what happened with this hospital beyond what I read in the newspapers. I can though discuss some of what my firm’s China lawyers have seen in possibly similar situations over the years and I do so below.

Maybe fifteen years, a very savvy foreign businessperson came to my law firm with a proposed deal that involved our client building a hotel. Just about everything about the deal was perfect. The location was perfect. The cost was perfect. The deal with the landlord was perfect. There was just one flaw: the land on which the hotel was to be built was owned by the military and that made the entire deal 100% illegal.

We explained the clear illegality of the deal (in writing of course) to our client, who already knew it. But like I said, this was a long time ago and our client was very savvy. His response was something like the following:

Yes, I know this deal is illegal and I know that means I am at risk of the government coming in and shutting us down the day after (or even before) we build the hotel. But we’ve run all the numbers on this and the numbers tell us that all we need to do for this deal to be an economic positive is last three years and every year after that the hotel will be a cash cow. So even though I know full well all the risks, I am willing to take them because I am willing to bet we can last at least three years.

The client did the deal and ended lasting for around eight years before shutdown and ended up making a lot of money. The client’s eight year tenure ended around 7-8 years ago and for probably the last ten years our China lawyers have simply said “no” to such deals, as they have simply become too risky. This does not mean our firm has not continued to see a slew of deals and WFOE formations we know violate China law. I can hear myself saying the following to the companies that bring us such deals and WFOE formations simply because I have said it so many times in my China law career:

What you are doing is illegal and you will get caught. When will you get caught? I don’t know that. It could be tomorrow or it could be a year from now. It probably will be in less than two years from now. Maybe if you had come to me ten years ago with this deal (or WFOE formation) I would not have been so unrelentingly negative about it, but China has changed. China has become incredibly serious about enforcing its laws (at least as against foreign companies, which are the only clients we have in China) and so we see every day what happens to foreign companies that are doing business in China or with China. Not only has China gotten more serious about enforcing its laws, it has gotten way better at enforcement. China is highly computerized and its various agencies and governmental bodies are quite sophisticated at communicating with each other.

We need to change your deal (or your WFOE formation). We are not going to put our reputation on the line for this sort of deal.

Oh, and one more thing. When you go back to your Chinese counterpart or to your own China employees/people on this, they will tell you I am exaggerating or I am naive or I just flat out “don’t know China.” I would never claim “to know China” because I don’t, but I do know is what happens to foreign companies that violate China law and I also know that at least once a month one of our China attorneys gets a call from a foreign company in trouble for having violated some law in China. And when I say trouble I mean they are facing millions of dollars in fines or closure of their operations or in some cases arrest and criminal charges.

Most of the time, the client then explains that they didn’t know that their deal (or WFOE) would be illegal (or as they often put it, “so illegal”). Some of the time though they do view us as naive or as overcautious and they move on.

In 2010, in Cracking Down On Illegal Land Use In China. Do You Really Still Feel Lucky, Foreign Punk? I wrote about foreign companies

The following is an amalgamation of a number (maybe 5 or 6) of conversations I have had over the years with people wanting to register a WFOE (Wholly Foreign Owned Entity) in China fast:

Potential Client: Can you help me register a WFOE in China.

Me: Yes. Not a problem. Do you have a lease yet? Do you know that a legitimate lease is required for the approval of a WFOE?

Potential Client: I know that but we are in a real hurry here.

Me:  Okay. But do you have a lease.

Potential Client: We have a lease but I don’t think it technically will qualify.

Me: What do you mean?

Potential Client: The land is zoned agricultural but my Chinese partner has secured all the okays to allow us to use it for our factory.

Me: Not a good idea. Trust me on that.

Potential Client: The factory has been there for two years without a problem and my Chinese partner assures me that the local government is fine with it.

Me: Don’t do it. Right now, the local government is okay with it. But what if the current mayor is pushed out next week on corruption grounds. Do you really want to be in a situation where you have spent a large amount of money on a space that gets shut down?

Potential Client: I am in a hurry and this is the only space that works.

Me: Are you sure? You are in a hurry, but is it really going to be worth the few months if you get shut down?

Potential Client: I am not going to get shut down. My Chinese partner is incredibly connected.

Me: Incredibly connected to the current local administration, MAYBE, but as I said, that administration could be out the door next week. Beijing checks on these things too and if they see that your facility is illegal, Beijing could see to its shut-down. I just don’t think it a good idea to go into a WFOE illegally and my firm cannot be a part of that.

Potential Client: That’s ridiculous. This is how business is done in China. Are you really saying you won’t take us.

Me: Yes. We won’t take you because we do not want our reputation damaged when you get shut down and we won’t take you because we do not want to be blamed when you get shut down.

Potential Client: Well I am sure I will have no trouble finding someone to help me on this. Good-bye.

I know that at least one of these companies did end up getting shut down (within about a year) because someone at the company who had sided with me on the company not going forward emailed me to tell me of this.

Now might be a good time for you to read the following:

Just yesterday, in China Law as California Law: There be Wolves out There, I wrote of how common it is for Chinese consumers and employees to sue foreign companies and I concluded that post with the following admonition on the importance of knowing and abiding by China law:

Yes, doing business in China is difficult and its laws are complicated, but that is true of pretty much every country I know. Be it California or China, it’s on you. People the world over — and that most certainly includes China — are ultra-litigious and that is not going to change soon if ever. Your defense to this is to know the laws and abide by them, to the letter. Saying that the laws are difficult or that there are bad people out there does not cut it and you ought to know that. Oral agreements in China are not worth the paper on which they are not printed and written agreements drafted by anyone not experienced with Chinese language contracts have no greater value.

You have been warned (yet again).

Today’s post is another warning.